Supply and Demand Explained: Why Prices Go Up and Down

Why did egg prices spike and then fall? Why does rent jump in some cities while staying flat in others? Why do airfares soar around the holidays? Much of the answer comes down to two of the most fundamental ideas in economics: supply and demand.

Understanding how supply and demand work won’t just help you follow economic news. It can also help you make smarter decisions about when and how to buy things.

What demand means

Demand is how much of something people want to buy at different prices. In general, when prices fall, people want to buy more, and when prices rise, they buy less. Economists call this the law of demand.

It makes intuitive sense. If your favorite coffee drops in price, you might buy it more often. If it doubles in price, you might cut back or switch to a cheaper option.

Many factors can shift overall demand beyond price. Changes in income, population, tastes and trends, the prices of related products and expectations about the future all play a role. If people expect prices to rise soon, for example, they may buy more now, increasing current demand.

What supply means

Supply is how much of something producers are willing and able to sell at different prices. Generally, higher prices encourage producers to make and sell more, because higher prices can mean higher profits. Lower prices tend to reduce how much producers are willing to offer.

Supply can shift for many reasons too, such as changes in production costs, technology, weather, natural disasters, disease, government policies like tariffs and the number of companies in a market.

Where prices settle

In a market, prices tend to move toward the point where the amount people want to buy matches the amount available. Economists call this the equilibrium price.

If demand is higher than supply, there are more buyers than available products, and prices usually rise. Higher prices then encourage producers to supply more and cause some buyers to purchase less, eventually bringing the market back toward balance.

If supply is higher than demand, sellers have more products than buyers want. Prices usually fall, which encourages more buying and discourages some production.

Real-world examples

Eggs offer a clear example. Outbreaks of avian influenza have, at times, reduced the number of egg-laying hens, cutting supply. Because people kept wanting eggs at roughly the same rate, prices rose sharply. As flocks recovered and supply increased, prices fell.

Housing is another example. When more people want to live in a city than there are homes available, often because of job growth or limited new construction, prices and rents tend to rise. Where new housing is built quickly to meet demand, price increases tend to be more moderate.

Holiday travel shows demand at work. Airfare and hotel prices often rise around major holidays, school breaks and big events, when many people want to travel at the same time. Supply, in the form of available seats and rooms, is limited, so prices climb.

Elasticity: how sensitive buyers are

Not all products respond to price changes the same way. Economists use the term elasticity to describe how much demand changes when prices change.

Demand for essentials like gasoline, basic groceries and medicine tends to be relatively inelastic, meaning people keep buying them even when prices rise, because they need them. Demand for luxuries and items with many substitutes tends to be more elastic. If the price of one brand of cereal rises, many shoppers simply switch to another.

How to use supply and demand to save money

Understanding these ideas can help you time purchases. Buying seasonal items out of season, when demand is lower, often means better prices, such as winter coats in spring, grills in fall or holiday decorations right after the holiday.

Being flexible with travel dates lets you avoid peak-demand periods when prices are highest. Flying midweek or traveling during shoulder seasons can save significantly.

When supply is plentiful and prices drop on non-perishable items you use regularly, stocking up can make sense, as long as you have room to store them and will use them before they expire.

Finally, when prices rise on something because of a temporary supply problem, look for substitutes. Switching to a similar product can save money while the market rebalances.

The bigger picture

Supply and demand don’t explain everything about prices. Government policies, market power, regulations and other factors also matter. But they offer a powerful starting point for understanding why prices move the way they do, and for making more informed choices with your money.